Goldman Sachs Needs a New Audit Committee: Jonathan Weil

May 26 (Bloomberg) -- Goldman Sachs Group Inc.’s reputation
sustained a body blow last year when the firm paid $550 million
to settle a fraud claim by the Securities and Exchange
Commission over its sales of a mortgage-bond deal called Abacus.
The integrity of its financial statements, however, has never
come under serious challenge.

Maybe investors should think twice, though, considering the
backgrounds of some of the directors responsible for ensuring
the sanctity of Goldman’s numbers.

Take James Schiro, who joined Goldman’s board in 2009 and
is the chairman of its audit committee. One of his jobs is to
make sure Goldman and its outside auditor,
PricewaterhouseCoopers LLP, remain "independent" of each other
and have no compromising mutual interests. You might even say
his qualifications for the role are unique, although this
wouldn’t be a compliment.

Schiro was PwC’s chief executive officer from 1998 to 2002.
During his tenure, an SEC investigation found more than 8,000
violations of auditor-independence rules by the Big Four
accounting firm, mostly related to partners who owned stock in
PwC audit clients.

In one instance, Schiro himself owned stock in an audit
client called Emcore Corp. After the SEC’s staff told Emcore in
1999 to drop PwC and get its books re-audited by another firm,
the company sued Schiro personally. Emcore dropped its suit,
which also named the firm and several other PwC partners as
defendants, after reaching a settlement in 2001. The terms
weren’t disclosed.

Gupta Accused

That history has added relevance because of the recent
travails of one man: Rajat Gupta, a former Goldman audit-committee member who left the company’s board last year. If
there was ever a moment when Goldman needed its audit panel’s
members to be unassailably clean, this would be it.

Gupta stands accused by the SEC’s enforcement division of
leaking confidential information from Goldman’s boardroom
meetings to Raj Rajaratnam, the former Galleon Group hedge-fund
manager convicted this month on insider-trading charges. (Gupta
denies the claims.) The question that naturally follows is how
many people on Goldman’s eight-member audit committee have track
records that should give investors pause.

James Johnson, a Goldman director since 1999, was CEO of
Fannie Mae from 1991 to 1998. An internal Fannie probe in 2006
led by former U.S. Senator Warren Rudman identified several
accounting violations that occurred on Johnson’s watch. Johnson
wasn’t accused by regulators of misconduct.

Lead Director

Goldman’s lead director, John Bryan, was on General Motors
Corp.’s board from 1993 to 2009 and served on its audit
committee from 1996 to 2001. The SEC accused GM of misstating
its financial results for several years, including 2000 and
2001, as part of a complaint settled in 2009; no individuals
were named as defendants.

Stephen Friedman, who remained on Goldman’s audit committee
after Schiro succeeded him last September as its chairman, drew
harsh criticism in 2009 following disclosures he had bought
Goldman shares while serving as chairman of the Federal Reserve
Bank of New York, one of Goldman’s regulators. While his trades
broke no rules, they were widely panned as unseemly, and he
resigned from the New York Fed under pressure.

Friedman also is a former chairman of Goldman; he retired
from the firm in 1994 when it was still a private partnership.
Technically he qualifies under the rules as an independent
member of Goldman’s board, allowing him to serve on its audit
committee. In substance, though, to say the guy who used to run
Goldman is independent of Goldman seems a bit much. (Goldman’s
audit committee is unusual in that all of the company’s non-executive directors serve on it.)

Trading Scandals

Ideally Goldman’s audit committee wouldn’t have any members
with questionable independence credentials or ties to past
accounting or trading scandals. Yet half of them do. All four
either declined to comment or didn’t return phone calls. A
Goldman spokesman, Lucas van Praag, declined to comment. So did
a PwC spokeswoman, Caroline Nolan.

As for Schiro, who was CEO of Zurich Financial Services AG
from 2002 to 2009, the years he was at the helm of PwC were some
of the most troubled in its history.

Among the firm’s audit clients were Tyco International
Ltd., Raytheon Co., Warnaco Group Inc., and Take-Two Interactive
Software Inc., all of which settled accounting-fraud complaints
with the SEC, without admitting or denying the allegations.
Tyco’s former CEO, Dennis Kozlowski, went to jail for looting
the company. The PwC audit partner who signed off on Tyco’s
books settled fraud accusations by the SEC, which permanently
barred him from auditing public companies.

SEC Reprimand

In 1999, the SEC censured the firm over the rash of
independence violations involving partners who owned shares of
PwC audit clients. It fined PwC $5 million in 2002 for a
separate batch of independence violations and faulty audits
covering 14 companies.

The SEC reprimanded PwC yet again in 2003 for professional
misconduct related to its 1998 audit work for a company called
SmarTalk TeleServices Inc. The next year, PwC paid $2.4 million
to settle SEC claims that it aided securities-law violations at
Warnaco in 1999. I could keep going, but you get the point.

A housecleaning is overdue.

(Jonathan Weil is a Bloomberg View columnist. The opinions
expressed are his own.)